If you're "house-rich and cash-poor," a reverse mortgage may be an appropriate income source during your retirement years. A reverse mortgage acts like a regular home mortgage in reverse. The equity in your home becomes a source of income, where the lender typically pays you a monthly payment. Each payment received reduces the equity in your home and increases the outstanding loan balance. The money received is usually tax-free. The payment is based on your age and the value of your home.
The outstanding loan balance — the amount you've received plus interest — doesn't have to be repaid until you die, sell the house, or move.
Reverse mortgages are complicated. Often the lender charges very high commissions and fees; be sure you completely understand the terms and costs before pursuing this option. Remember, you will be depleting the equity you have in your home, which will mean fewer assets for you and your heirs. Make sure it is right for you.
There are three types of reverse mortgages.
- Single-purpose reverse mortgages are the least expensive, but limit the use of the loan to one purpose that the lender specifies, such as home improvements, repairs, or property tax. These are offered by some state and local agencies but are not available everywhere.
- Proprietary reverse mortgages are offered by private companies and can provide bigger loan advances for those with higher-value homes and small mortgages.
- Home Equity Conversion Mortgage, or HECM, is available through an FHA-approved lender and can be used for any purpose. They are federally insured and backed by the U.S. Department of Housing and Urban Development (HUD). You need to be a homeowner age 62 or older and have paid off your mortgage or paid down a considerable amount and are currently living in the home. You can research this option, including all the requirements, through the HUD website.
Here are some items to consider about reverse mortgages:
- There are fees and other costs. Reverse mortgage lenders generally charge an origination fee and other closing costs, as well as servicing fees over the life of the mortgage. Some also charge mortgage insurance premiums.
- You owe more over time. Your loan balance increases over time as the monthly payments you receive and interest are added to the balance you owe. As the loan balance increases, so does the interest added each month.
- Interest rates may change over time. Most reverse mortgages have variable rates, which are tied to a financial index and change with the market. Some reverse mortgages – mostly HECMs – offer fixed rates, but they tend to require you to take your loan as a lump sum at closing, rather than sending a payment each month.
- Interest is not tax-deductible each year. Interest on reverse mortgages is not deductible on income tax returns until the loan is paid off, either partially or in full.
- You have to pay other costs related to your home. In a reverse mortgage, you keep the title to your home. That means you are responsible for property taxes, insurance, utilities, fuel, maintenance, and other expenses.
- What happens to your spouse? With HECM loans, if you signed the loan paperwork and your spouse didn’t, in certain situations, your spouse may continue to live in the home even after you die as long as he or she pays taxes and insurance, and continues to maintain the property. But your spouse will stop getting money from the HECM, since he or she wasn’t part of the loan agreement.
- What can you leave to your heirs? Reverse mortgages can use up the equity in your home, which means fewer assets for you and your heirs. Most reverse mortgages have a “non-recourse” clause. This means that you, or your estate, can’t owe more than the value of your home when the loan becomes due and the home is sold.